Citigroup Inc is a case study of an investment opportunity we highlighted for our subscribers in May 2016 and Close of in October this year. Over an 18 months period this idea generated a 75% return.
In this case study we will cover why we found the company attractive, what happened after we covered the stock and how Reid Green & Co approaches the investment problem.
What was it about Citigroup Inc that made Reid Green & Co rate it a buy a $43.15 per share and a sell at $74.05 per share?
Citigroup Inc. (Citi) is a financial services holding company. The Company's whose businesses provide consumers, corporations, governments and institutions with a range of financial products and services, including consumer banking and credit, corporate and investment banking, securities brokerage, trade and securities services and wealth management.
In 2016 due to a negative sentiment in the banking sector related to banks’ exposure to commodities which were in the doldrums at the time, Citigroup found itself trading at a 30% discount to its tangible equity and at more than a 40% discount to its reported book value. Some of the discount was also part of a punishment for Citigroup appearing to generate a meagre 8% return on its equity, meanwhile Reid Green & Co thought the correct to look at Citigroup equity was the same way the banking regulators look at their equity.
Upon looking at the company’s regulatory equity, which as must lower than its stated equity, we concluded than compared to Citigroup’s earnings it was actually earning closer to 11% of its true equity and factoring the discount this set up an attractive investment situation. An excerpt of what we told our subscribers can be seen below:
“However, we think Citigroup’s compliance with US GAAP accounting standards is masking the banks much higher return on equity, as items such preferred stock, deferred tax assets, goodwill and intangible assets bloats the banks equity.
When you deduct the $16 billion in outstanding preferred stock and $25.5 billion in intangible assets from the company’s equity, you realise that the bank’s tangible equity is actually $179.5billion or $60.77 per share, which would indicate a return on tangible equity of 9.4%.
In spite of the above, the regulators actually have an even more nuanced view on the banks equity, one that we think gets closer to revealing the banks true economic performance.
In assessing the banks regulatory equity, not only do the regulators deduct the preferred equity and intangibles, but they also subtract $32 billion of the Citi’s deferred tax assets. This results in $147 billion in regulatory equity or $50per share and when compared to its 2015 net income results in an 11.5% return on equity. This is 50% higher than the headline numbers would suggest.
In summary our basic valuation takes into account the fact that the bank generates an 11% return on equity, is well capitalised with 12% in regulatory equity, is growing its core lending business, has $30 billion deferred tax assets which allows it to earn $100 billion of tax-free profits, and its excess earnings either gets returned to shareholder via buybacks or increases the company’s tangible equity.
What happen after Reid Green & Co covered the stock?
During October 2017 Citigroup announced:
In the first three quarters of the 2017 financial year ended 30 sept Citigroup Inc:
- Increased its tangible book value to $68 per share up 13% from $60 in 2015.
- Increased its common equity from 8.7% in 2012 to 13%
- Repurchased 140 million common shares and returned $10.8 billion to shareholders
- Maintained a 9% return on tangible capital and 11% return on regulatory capital
What was the final outcome?
At the time of recommended Citigroup Inc as a sell the (25th October 2017) the stock was trading at $74.05 with a market cap of $195billion, which was 75% higher than when we initially covered the stock. Reid Green & Co subscribers, who bought the stock around the time of our first report, generated a return of approximately 75% in 18 months.
Reid Green & Co looks for situations that have created large mis-pricings
Although Citigroup Inc was much larger than the typical company we cover today, the investment thesis was a textbook example of what we look for in an investment opportunity. Reid Green & Co seeks out high-quality companies, whose stocks prices for one reason or another do not reflect the true value of the business.
More often than not we look for situations were there are multiple possible but highly likely catalyst for realising the underlying value, as in Citigroup’s case as long as the company generated earnings the profit would either be added to the company’s balance sheet and thus increase its book value per share or it would be distributed back to shareholders in accretive stock buybacks. Both of which would increase or realise intrinsic value.
On behalf of our subscribers Reid Green & Co will continue to look for such opportunities.